There isn't just one best method for evaluating business performance. Every business may differ slightly in operation, environment and methodology, which leaves many trial and error opportunities. Financial statement analysis provides a primary foundation for evaluating business performance and adapts to every business. All owners and managers should be skilled in analyzing financial statements to understand the impact business decisions will have on the organization.

Cost-Volume-Profit

Cost-volume-profit analysis provides owners and managers with an understanding of the relationship between fixed and variable costs, volume of products manufactured or sold and the profit resulting from sales. The financial relationship includes contribution margin analysis, break-even analysis and operational leverage. Financial statements provide the data to perform cost-volume-profit analysis.

Contribution Margin

Contribution margin analysis allows managers to look at the percentage of each sales dollar remaining after payment of variable costs, including cost of goods, commissions and delivery charges. Managers and owners use this analysis to help determine the pricing, mix, introduction and removal of products. Contribution margin analysis also aids managers with determining how much incentive to use for sales commissions and bonuses. Comparing each product offered affords the opportunity to look at product profitability and product mix.

Break-even

Break-even analysis considers the sales volume at which fixed and variable costs are even. Owners and managers must consider two primary figures when calculating the break-even. First, gross profit margin, which is the percentage of sales remaining after payment of variable costs. And fixed costs, including administration, office and marketing. Financial statements provide both sets of data necessary to calculate the break-even volume.

Operational Leverage

Every business model contains slightly different operating leverage, which compares the amount of fixed costs to sales. Businesses with higher fixed costs will experience a larger multiplier in their operating leverage, indicating less sales growth results in more profit. However, the same is true for losses, where small reductions in sales exponentially increase net losses. Less operating leverage results in less growth of net income.

Financial Ratios

A financial ratio expresses a mathematical relationship between two or more sets of financial statement data and commonly exhibits the relationship as a percentage. Profitability, solvency, leverage, asset turnover and liquidity comprise the five standard ratio categories. Managers and owners should review the ratios period over period, determining where unfavorable trends exist. After reviewing trends, benchmark ratios against industry standards, which managers can acquire from a variety of sources including industry-specific organizations and the Risk Management Association, or RMA (see Resources).

About the Author

Jeremy Slaughter began writing business and hobby articles in 2009 after completing his master's degree in accounting at the Keller Graduate School of Management. As a tax, accounting and small business expert, Slaughter co-founded an accounting and tax firm where writing plays a daily role.